Why Budget 2015 will be different: it may push fiscal federalism harder

Budget 2015 has the potential to be India’s most important one since 1991. Not because budgets are normally meant to be path-breaking, but because the first budget of the Narendra Modi government last year was a damp squib, a mere continuation of the trajectory set by the UPA.

Arun Jaitley’s second budget thus has the chance to break away and establish its own claim to fame. And the only way to make it stand out is by including strong political and economic signaling in it. In fact, both messages must convey the same intent.

What should that one thing be that ties the political with the economic?

Answer: federalism. The budget must unequivocally emphasise the formal transfer of more economic power and resources to the states. The reason is not only the report of the 14th Finance Commission, which is expected to recommend a greater transfer of fiscal resources to states, but because federalism is the only way to make both Centre and states stronger. Growth cannot be speeded up if Centre and state work at cross purposes.

The Economic Times today (18 February) says the along with the transfer of resources, the Centre will also trim its own social sector schemes to emphasise this shift to federal principles.

A beginning was made in Jaitley’s last budget itself, when he showed the bulk of the social sector schemes as part of state plans. The share of state plans financed by the Centre moved up last year from 26 percent of total plan expenditure to 59 percent. This year, both the resources and plans will go to the states directly.

But while this is good, one hopes Modi and Jaitley go the whole hog and do not do things by halves. The idea should be to shrink the share of Central budgets and expand those of states over time.

The problem is Modi himself has launched schemes that will not really succeed without state involvement. Take the Make in India campaign to make India a manufacturing hub. While it is extremely well-thought-out in terms of marketing India to the world, and in identifying sectors where manufacturing may work, the Centre itself cannot make it fly in any field beyond defence manufacturing - which too needs state support in terms of land supplies and related facilities.

Make in India will succeed only if states take it up. It is Make in Bengal, Make in Maharashtra and Make in Assam that with make or unmake Make in India.

Or take Swachh Bharat, the PM’s pet programme to build toilets, end open defecation and improve public hygiene and cleanliness. He can raise funding for it, through a Central cess or other means, but garbage and toilets are really the jobs of local bodies, especially municipalities. It is not even what state governments can do something about, though they do have some powers over local bodies. How is the Centre going to ensure Swachh Bharat succeeds in its mission by 2019, Modi’s target end date that coincide with the 150th birth anniversary of Mahatma Gandhi, unless there is a buy-in for Swachh Mumbai, Swachh Patna, or Swachh Dehradun?

On the other hand, Jan Dhan Yojana (for inclusive banking) and direct benefits transfers (on LPG, kerosene, etc) are bang in the area of Central control. The Centre controls the banking system in every state and Central subsidies can go directly to citizens. Modi can make these schemes work precisely because he controls them from end to end.

The budget, and the political messaging to flow from it, must thus render unto states the things that are theirs and retain for the Centre only the things that it can control and implement directly.

For too long, India has tied itself into knots due to its inability to sort out Centre-state power issues. The reality is that political power flows upwards from states, while economic power flows downwards from the Centre to states and local bodies. The budget, and all subsequent actions to it, must shift economic power and resources to states.

What this means is the following:

First, the Centre must stop legislating social schemes in areas where the states have to do all the work. It is best to transfer all such existing schemes to states (as seems to be happening), and also avoid announcing such schemes in future. Schemes like NREGA, National Rural Health Mission and the Food Security Act should all be in the state sector. If the Centre wants to enact such schemes, it should make them fully grant-based and ask states to come up with scheme they want in these areas.

Second, legislation involving the concurrent list should explicitly be avoided, unless there is a uniform demand from states for a Central law. A case in point is the Land Acquisition Act, which is impeding growth, which few states want, but the Centre ended up legislating. If Narendra Modi cannot get his ordinance to amend the Act passed, he should simply say he will allow any state making its own law to go ahead. The centre will give its assent without fuss.

Narendra Modi needs accept the reality that his initiatives will be most successful in areas that fall bang in the centre’s domain and need no state consent. This means defence, internal security, the higher judiciary, foreign affairs, monetary and fiscal policy, direct taxation, etc.

Future budgets need to keep this in mind. A part of this message should come from the 2015 budget too.